SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-36980; File No. SR-NASD-95-63)
March 15, 1996
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by National Association of Securities Dealers, Inc.
Relating to Regulating the Conduct of Broker/Dealers Operating on
the Premises of a Financial Institution
Pursuant to Section 19(b)(1) of the Securities Exchange Act
of 1934 ("1934 Act"),-[1]- notice is hereby given that on
December 28, 1995, the National Association of Securities
Dealers, Inc. ("NASD" or "Association") filed with the Securities
and Exchange Commission ("SEC" or "Commission") the proposed rule
change as described in Items I, II, and III below, which Items
have been prepared by the NASD. The filing was subsequently
amended on January 24, January 29 and March 7, 1996.-[2]-
The Commission is publishing this notice to solicit comments on
the proposed rule change from interested persons.
I. SELF-REGULATORY ORGANIZATION'S STATEMENT OF THE TERMS OF
SUBSTANCE OF THE PROPOSED RULE CHANGE
The NASD is proposing to add a new section specifying
requirements for broker/dealer conduct on the premises of a
financial institution. Below is the text of the proposed rule
change.
RULES OF FAIR PRACTICE
Broker/Dealer Conduct on the Premises of Financial Institutions
Sec. ____.
(a) Applicability
This section shall apply exclusively to those broker/dealer
services conducted by members on the premises of a financial
institution where retail deposits are taken. This section does
not alter or abrogate members' obligations to comply with other
applicable NASD rules, regulations, and requirements, nor those
of other regulatory authorities that may govern members operating
on the premises of financial institutions.
(b) Definitions
(1) For purposes of this section, the term "financial
-[1]- 15 U.S.C. 78s(b)(1).
-[2]- See Letters from Elliott R. Curzon,
Associate General Counsel, NASD, to Mark P. Barracca, Branch
Chief, Division of Market Regulation, SEC (January 24, 1996 and
March 7, 1996) and Letter from Suzanne E. Rothwell,
Associate General Counsel, NASD, to Mark P. Barracca, Branch
Chief, Division of Market Regulation, SEC (January 29, 1996).
This notice reflects those amendments. The text of the
amendments may be examined in the Commission's Public Reference
Room.
==========================================START OF PAGE 2======
institution" shall mean federal and state-chartered banks,
savings and loan associations, savings banks, credit unions, and
the service corporations required by law of such institutions.
(2) "Networking arrangement" and "brokerage affiliate
arrangement" shall mean a contractual arrangement between a
member and a financial institution pursuant to which the member
conducts broker/dealer services for customers of the financial
institution and the general public on the premises of such
financial institution where retail deposits are taken.
(3) "Affiliate" shall mean a company which controls, is
controlled by or is under common control with a member as defined
in Schedule E of the By-Laws.
(4) "Broker/dealer services" shall mean the investment
banking or securities business as defined in Paragraph (l) of
Article I of the By-Laws.
(5) "Confidential financial information" shall not include:
(A) customers' names, addresses, and telephone
numbers, unless a customer specifies otherwise;
or
(B) information that can be obtained from unaffiliated
credit bureaus or similar companies in the
ordinary course of business.
(c) Standards for Member Conduct
No member shall conduct broker/dealer services on the
premises of a financial institution unless the member complies
initially and continuously with the following requirements:
Setting
(1) Wherever possible, the member's broker/dealer services
shall be conducted in a physical location distinct from the area
where the financial institution's retail deposits are taken. In
all situations, members shall identify the member's broker\dealer
services in a manner that is clearly distinguished from the
financial institution's retail deposit-taking activities. The
member's name shall be clearly displayed in the area in which
the member conducts its broker/dealer services.
Networking and Brokerage Affiliate Agreements
(2) Networking and brokerage affiliate arrangements between
a member and a financial institution must be governed by a
written agreement that sets forth the responsibilities of the
parties and the compensation arrangements. The member must
ensure the agreement stipulates that:
(A) supervisory personnel of the member and
representatives of the Securities and Exchange
Commission and the Association will be permitted
access to the financial institution's premises
where the member conducts broker/dealer services
in order to inspect the books and records and
other relevant information maintained by the
member with respect to its broker/dealer services;
==========================================START OF PAGE 3======
(B) unregistered employees of the financial
institution will not receive any compensation,
cash or non-cash, that is conditioned on whether a
referral of a customer of the financial
institution to the member results in a
transaction; and
(C) the member will notify the financial institution
if any associated person of the member who is
employed by the financial institution is
terminated for cause by the member.
Compensation of Registered/Unregistered Persons
(3) The member shall not provide cash or non-cash
compensation to employees of the financial institution who are
not registered with an NASD member in connection with, but not
limited to, locating, introducing, or referring customers of the
financial institution to the member.
Customer Disclosure and Written Acknowledgment
(4) (A) When a customer account is opened by a
broker/dealer on the premises of a financial
institution where retail deposits are taken, the member
shall disclose, orally and in writing, that the
securities products purchased or sold in a transaction
with the member:
(i) are not insured by the Federal Deposit
Insurance Corporation ("FDIC") or other
applicable deposit insurance;
(ii) are not deposits or other obligations of the
financial institution and are not guaranteed
by the financial institution; and
(iii) are subject to investment risks,
including possible loss of the principal
invested.
(B) For all accounts opened by a broker/dealer on the
premises of a financial institution where retail
deposits are taken, the member shall make reasonable
efforts to obtain from each customer during the account
opening process a written acknowledgement of the
disclosures required by Subsections (c)(4)(A)(i)
through (iii).
Use of Confidential Financial Information
(5) The member shall not use confidential financial
information provided by the financial institution regarding its
customer unless prior written approval has been granted by the
customer to release the information.
Communications with the Public
(6) (A) All member communications regarding customers'
securities transactions and long and short positions,
including confirmations and account statements, must
indicate clearly that the broker/dealer services are
provided by the member. Communications that include
information regarding non-deposit-insured transactions
and positions with the member and deposit-insured
==========================================START OF PAGE 4======
transactions and positions or accounts with the
financial institution should distinguish clearly
between the two. Securities transactions conducted by
the member should be introduced with the member's
identity and, at a minimum, the member must disclose
that securities products: are not insured by the FDIC
or other applicable deposit insurance; are not deposits
or other obligations of the financial institution and
are not guaranteed by the financial institution; are
subject to investment risks, including possible loss of
the principal invested.
(B) Advertisements, sales literature, and other similar
materials issued by the member that relate exclusively
to its broker/dealer services will be deemed to be the
materials of the member and must indicate prominently
the identity of the member providing the broker/dealer
services. The financial institution may be referenced
in a nonprominent manner in advertising or promotional
materials for the purpose of identifying the location
where broker/dealer services are available and, where
appropriate, to disclose a material relationship
between the member and the financial institution, for
example, where the member is affiliated with a
financial institution that serves as investment adviser
to an open-end investment company ("mutual fund").
(C) Advertisements, sales literature, and other similar
materials jointly issued by the member and a financial
institution that discuss services or products offered
by both entities must distinguish clearly the products
and services offered by the financial institution from
those offered by the member. The name of the member
must be displayed prominently in the section of the
materials that describes the broker/dealer services
offered by the member, which section will be deemed
materials of the member.
II. SELF-REGULATORY ORGANIZATION'S STATEMENT OF THE PURPOSE OF,
AND STATUTORY BASIS FOR, THE PROPOSED RULE CHANGE
In its filing with the Commission, the NASD included
statements concerning the purpose of and basis for the proposed
rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be
examined at the places specified in Item IV below. The NASD has
prepared summaries, set forth in Sections (A), (B), and (C)
below, of the most significant aspects of such statements.
(A) Self-Regulatory Organization's Statement of the Purpose
of, and Statutory Basis for, the Proposed Rule Change
(1) Background
In recent years, banks, savings and loan associations,
credit unions and similar financial institutions not registered
as a broker/dealer under the 1934 Act ("financial institutions")
have expanded their business into retail securities sales. These
==========================================START OF PAGE 5======
institutions generally conduct such activities through affiliated
broker/dealers or non-affiliated broker/dealers operating under a
brokerage affiliate or networking arrangement. In addition,
however, banks are exempt from the definitions of the terms
"broker" and "dealer" in Sections 3(a)(4) and 3(a)(5),
respectively, of the 1934 Act, and thus are not required to
register as broker/dealers when selling securities.
As these securities activities have expanded and financial
institutions have placed securities sales facilities in their
retail deposit taking areas, customers of the financial
institutions have become increasingly confused about the
distinction between the insured deposit products of the financial
institution and the uninsured securities products of the
broker/dealer operating in the same location.
In order to address this customer confusion problem, the
NASD has published several notices reminding members of their
obligations under the federal securities laws and the NASD's
rules when selling securities products to customers who may have
little or no experience with uninsured, non-depository products.
In Notice to Members 91-74 (November 1991) and Notice to Members
93-87 (December 1993), the NASD reminded members of their
obligations to customers who were reinvesting maturing
certificates of deposit. In addition, in Notice to Members 94-16
(March 1994) the NASD reminded members of their sales practice
obligations in connection with mutual fund sales and noted that
the growth of bank-affiliated and networking broker/dealers had
focused attention on the issue. Finally, in Notice to Members
95-80 (September 26, 1995) the NASD addressed additional concerns
regarding member obligations and responsibilities regarding
mutual fund sales practices.
In Notice to Members 94-47 (June 1994) the NASD published
the SEC's November 24, 1993 no-action letter to the Chubb
Securities Corporation (the "Chubb Letter") concerning
broker/dealer activity on the premises of a financial
institution. The Chubb Letter set forth the requirements for
networking broker/dealers as they related to customer disclosure,
compensation of employees of the financial institution,
promotional materials of the broker/dealer, location of the
securities activities of the broker/dealer, and inspection of
books and records with respect to financial institutions that are
subject to broker/dealer registration under Section 15(a) of the
1934 Act.
In addition, on February 15, 1994, the various financial
institution regulators-[3]- issued a joint statement titled
the "Interagency Statement on Retail Sales of Nondeposit
-[3]- The Board of Governors of the
Federal Reserve
System ("FRB"), the Federal Deposit Insurance
Corporation, the
Office of the Comptroller of the Currency ("OCC"), and
the Office
of Thrift Supervision ("OTS") ("financial
institution
regulators").
==========================================START OF PAGE 6======
Investment Products" (the "Interagency Statement"). The
Interagency Statement established guidelines for financial
institutions that sell securities products to their customers,
either directly or through networking or affiliated
broker/dealers. It is the NASD's understanding that, to the
extent securities are being sold by broker/dealers operating on
financial institution premises, NASD members are observing the
requirements of the Interagency Statement even though such
broker/dealers are not directly subject to the jurisdiction of
the financial institution regulators.
The NASD has been concerned that the activities of member
firms operating on the premises of financial institutions and
related customer protection issues are not adequately addressed
by existing NASD rules and, because the Interagency Statement has
no jurisdictional reach to broker/dealers, there is no basis for
NASD disciplinary action against member firms that do not comply
with the terms of the Interagency Statement. Accordingly, the
NASD is proposing to add a new section to the Rules of Fair
Practice to govern the conduct of broker/dealers on the premises
of financial institutions.
(2) Description of Proposed Rule
Applicability. Subsection (a) of the proposed rule provides
that the new section applies exclusively to broker/dealer
services being conducted by NASD members on the premises of a
financial institution where retail deposits are taken.
Subsection (a) specifies that the proposed rule covers
financial institutions that have an area "where retail deposits
are taken." The NASD intends that the phrase "where retail
deposits are taken" will have its ordinary meaning; i.e., a
financial institution with an area where, with minimal
limitations, the public (or members, in the case of a credit
union) can access the services of the institution. It would not
include financial institutions that do not generally provide
access to the public without an appointment, e.g., financial
institutions which solely provide trust services or private
banking services.
Subsection (a) also provides that the section only applies
to situations where broker/dealer services are conducted "on the
premises of a financial institution where retail deposits are
taken" (emphasis added). The proposed rule will apply to
broker/dealer services provided (including all accounts opened)
in person by broker/dealer personnel on the premises of the
financial institution, as well as broker/dealer services provided
by telephone or other means of communication (including computer
terminals) by broker/dealer personnel on the premises of the
financial institution. The proposed rule change will also apply
to broker/dealer services provided by a broker/dealer via the
telephone or other means of communication to customers who are on
the premises of a financial institution even if the broker/dealer
personnel themselves may not be on the premises of the financial
institution.
If the broker/dealer is conducting business in a physically
==========================================START OF PAGE 7======
separate location from the retail facility of the financial
institution and is not otherwise present on the premises of the
financial institution via computer terminal or other electronic
communication, the rule does not apply. For example, a
broker/dealer operating in separate office space on another floor
or in another part of the same building, even if the building is
owned or primarily occupied by the financial institution, and
where the entrance to the broker/dealer's office space is through
the building lobby or an exterior entrance and not through the
financial institution's retail facility, the broker/dealer will
be considered to be conducting its services in a physically
separate location.
Subsection (a) also expressly states that the proposed rule
does not alter or abrogate the member's obligation to comply with
other NASD rules or the rules of other financial institution
regulatory authorities with respect to the member's operations on
the premises of a financial institution.
(3) Definitions.
Subsection (b) of the proposed rule defines several terms
used in the proposed rule, such as, "financial institution,"
"networking arrangement" and "brokerage affiliate arrangement,"
"affiliate," "broker/dealer services," and "confidential
financial information." Each of the definitions are discussed
below in connection with the provisions of the proposed rule
where they are used. The definition of "financial institution"
applies only to the proposed rule change; not to other provisions
of the NASD's rules.
(4) Standards for Member Conduct.
Subsection (c) of the proposed rule sets forth the specific
requirements for members doing business on the premises of a
financial institution as they relate to:
1. Setting;
2. Networking and brokerage affiliate agreements;
3. Compensation of registered and unregistered
persons;
4. Customer disclosure and written acknowledgement;
5. Use of confidential financial information; and
6. Communications with the public.
The introduction to subsection (c) provides that no member
shall conduct broker/dealer services on the premises of a
financial institution-[4]- unless the member complies
initially and continuously with the requirements of the proposed
rule.
Setting. Subsection (c)(1) states that, wherever possible,
-[4]- The term "financial institution" is
defined in
proposed subsection (b)(1) as federal and state
chartered banks,
savings and loans, savings banks, credit unions and
the service
corporations required by law of such institutions.
==========================================START OF PAGE 8======
broker/dealer services-[5]- shall be conducted in an area
physically distinct from the retail deposit taking area of the
financial institution. In all situations, the broker/dealer
services must be identified in a manner that clearly
distinguishes them from the activities of the financial
institution. Finally, a member must clearly display its name in
the area where broker/dealer services are provided.
The NASD recognizes that physical limitations in the space
occupied by some financial institutions may prevent ideal
physical distinctions of broker/dealer activities from the retail
deposit-taking area of the financial institution from being
maintained. Accordingly, the NASD has qualified the physical
distinction requirement in this provision by the phrase "wherever
possible."
In addition, the provision requires members to identify and
clearly distinguish their activities from those of the financial
institution, and to clearly display the member's name in the area
where broker/dealer services are provided. The NASD expects that
the three requirements in this provision, working in combination,
will achieve the desired result, that is, the elimination of
confusion among customers of the financial institution over which
entity they are doing business with. The NASD expects that
members unable to achieve ideal physical distinction of their
broker/dealer activities from the financial institution's retail
deposit taking area will pay particular attention to the other
provisions of subsection (c)(1) in order to eliminate customer
confusion and misidentification.
Finally, the NASD is aware of circumstances where financial
institutions conduct business from walkup windows, kiosks or
desks in public places, such as supermarkets or similar
locations, many of which are operated by a single person. While
the NASD cannot anticipate how the proposed rule would apply in
all possible scenarios, the NASD believes it may be particularly
difficult to adequately distinguish between the activities of the
financial institution and the member as required by subsection
(c)(1) in a setting such as a walkup window, kiosk or desk
-[5]- The term "broker/dealer services" is
defined in
proposed subsection (b)(4) as meaning investment
banking or
securities business as defined in paragraph (l) of
Article I of
the By-Laws. Paragraph (l) of Article I reads:
(l) "investment banking or securities
business" means
the business, carried on by a broker, dealer, or
municipal
securities dealer (other than a bank or
department or
division of a bank), or government securities
broker or
dealer of underwriting or distributing issues of
securities,
or of purchasing securities and offering the
same for sale
as a dealer, or of purchasing and selling
securities upon
the order and for the account of others.
==========================================START OF PAGE 9======
operated by a single person. Some of the difficulties with such
settings could be resolved if the member exercises exceptional
caution and adopts specific operational controls designed to
avoid customer confusion and adequately distinguish its
operations from those of the financial institution. However, the
NASD expects members to be aware that there may be certain
business settings of financial institutions where the member will
not be able to comply with the requirements of subsection (c)(1),
and may, therefore, be prevented from conducting business in such
a location.
Networking and Brokerage Affiliate Agreements. Subsection
(c)(2) of the proposed rules specifies that networking-[6]-
and brokerage affiliate-[7]- arrangements between a member
and a financial institution must be governed by a written
agreement that sets forth the responsibilities of the parties and
the compensation arrangements, including: (1) access by
broker/dealer supervisory and regulatory persons to the financial
institution's premises to inspect the member's books and records;
(2) a prohibition on transaction-related cash or non-cash
compensation to unregistered employees of the financial
institution for referrals of financial institution customers to
the member; and, (3) the member's obligations to notify the
financial institution if any associated person of the member is
terminated for cause. The proposed rule explicitly contemplates
that members will not be able to conduct a securities business on
the premises of a financial institution unless a written
agreement that complies with subsection (c)(2) is in place.
The requirement that the agreement provide for access by the
member's supervisory and NASD and SEC regulatory personnel to the
financial institution's premises is intended to ensure that the
existing right of such persons and entities to examine the books
and records of the member, are not affected by the fact that the
member is located on the premises of a financial institution.
Compensation of Registered/Unregistered Persons. Proposed
-[6]- The terms "networking arrangement" and
"brokerage
affiliate arrangement" are defined in proposed
subsection (b)(2)
as a contractual arrangement between a member and a
financial
institution permitting the member to provide
brokerage services
on the premises of the financial institution.
-[7]- The term "affiliate" is defined in
proposed
subsection (b)(3) as a company which controls, is
controlled by
or is under common control with a member as defined in
Schedule E
of the NASD By-Laws. The formulation of this
definition is
consistent with definitions elsewhere in the
securities laws,
principally Section 20 of the 1934 Act. The NASD is
also making
express reference to the more detailed definition of
affiliate in
Schedule E, Section 2(a), in order to provide
additional guidance
to members about what constitutes an affiliate.
==========================================START OF PAGE 10======
subsection (c)(3) prohibits members from providing cash or
non-cash compensation to employees of the financial institution
who are not registered with an NASD member. Activities for which
members may not compensate unregistered persons include, but are
not limited to, those activities which, under the 1934 Act, may
only be conducted by a registered broker/dealer or a person
associated with a registered broker/dealer: the activities
include, but are not limited to, locating, introducing, or
referring customers of the financial institution to the member.
Customer Disclosure and Written Acknowledgment. Proposed
subsection (c)(4) specifies the disclosures that a member must
make to a customer when the customer opens an account with the
member on the premises of a financial institution. Members must
disclose, orally and in writing, that securities products sold in
a transaction with the member: (1) are not insured by the Federal
Deposit Insurance Corporation ("FDIC") or other applicable
deposit insurance; (2) are not deposits or obligations of, nor
are they guaranteed by, the financial institution; and (3) are
subject to investment risks, including loss of principal
invested. The proposed disclosures are consistent with the
disclosure provisions in the Interagency Statement.
The NASD is proposing these disclosure provisions to address
and eliminate customer assumptions and confusion that the
securities they are purchasing from broker/dealers operating on
the premises of financial institutions are either insured or
guaranteed against loss of principal. Such beliefs apparently
arise because customers mistakenly assume that the same insurance
and guarantees that cover the deposit-type products of the
financial institution also cover the securities products of the
broker/dealer.
Subsection (c)(4) also requires members to make reasonable
efforts to obtain a written acknowledgement of the required
disclosures during the account opening process. This provision
is intended to complement the oral and written disclosures
members are required to give to customers opening new accounts on
the premises of a financial institution. At the time the account
is opened the member will provide the disclosures, both orally
and in writing, and then seek to have the customer acknowledge
the disclosures in writing. Because some customers may be
reluctant to provide the written acknowledgement at the time the
account is opened (or, indeed, at any time), the NASD is not
mandating that the acknowledgement be obtained, just that the
member make reasonable efforts to obtain it.-[8]-
Use of Confidential Financial Information. Proposed
subsection (c)(5) prohibits members conducting business on the
premises of a financial institution from using confidential
-[8]- The approach taken by the NASD in this
provision
is consistent with the approach adopted by the NASD in
connection
with obtaining suitability information under
Article III,
Sections 2(b) and 21 of the Rules of Fair Practice.
==========================================START OF PAGE 11======
financial information provided by the financial institution
unless prior written approval has been granted by the financial
institution customer to release the information. Proposed
subsection (b)(5) defines "confidential financial
information"-[9]- in terms of what it is not: i.e., it is
not lists of customer names, addresses and telephone numbers,
unless the customer has specified otherwise; and it is not
information that could be obtained from unaffiliated credit
bureaus-[10]- or similar companies in the ordinary course
of business. Therefore, information concerning a customer that a
member obtains from a financial institution with which it has a
networking or brokerage affiliate arrangement (other than the
name, address, and telephone numbers of the customer, or that the
member could obtain on its own from an unaffiliated credit
bureau) may not be used unless the customer has granted prior
written approval to the financial institution to release the
information. Moreover, a member must satisfy itself that the
customer has granted permission to release the information,
either by obtaining copies of the written release from the
financial institution, or by obtaining approval directly from the
customer to release the information, before the member is
permitted to use such information. In accordance with the intent
of this provision, a member may not, for example, use a customer
list sorted by the financial institution according to a field of
information that would be confidential if released as individual
customer information; e.g., lists of customers with expiring
Certificates of Deposits or net worth in excess of $100,000.
Communications With the Public. Proposed subsection (c)(6)
sets forth requirements for all communications with customers of
members operating on the premises of a financial institution,
including, account statements, confirmations, advertisements and
sales literature. Paragraph (c)(6)(A) requires that all
communications regarding the securities transactions of customers
of members doing business on the premises of a financial
institution clearly indicate that the broker/dealer services are
provided by the member. Moreover, communications that include
information about non-deposit-insured transactions and positions
with the member and deposit-insured transactions and positions or
---------FOOTNOTES----------
-[9]- The NASD states that the definition of "confidential
information"
is based on the language of HR 1062 pending in the
U.S. House of
Representatives and the "credit bureau" exception is intended to
except from
the provision information regarding a customer that the member
can obtain in
the ordinary course of its business.
-[10]- NASD staff believes that standard information
maintained by a
credit bureau relates to credit history events, such as
liens, loans
outstanding, lines of credit, and credit cards, as opposed
to net worth
information that would include the value of customer assets, such
as property,
depository accounts, certificates of deposit, securities,
and other
investments.
==========================================START OF PAGE 12======
accounts with the financial institution should be clearly
distinguished from each other. The NASD also notes that if
members issue account statements jointly with a financial
institution, the member must ensure that the account statement
complies with Article III, Section 45 of the Rules of Fair
Practice, which requires members to periodically send account
statements to their customers, as well as with the proposed new
provision.
Finally, communications about securities transactions
conducted by the member should be introduced to the customer in
such communications with the identity of the member, and disclose
to the customer that securities products are not insured by the
FDIC or other applicable deposit insurance, are not deposits or
obligations of the financial institution, are not guaranteed by
the financial institution, and are subject to investment risks,
including possible loss of principal invested. This provision is
intended to provide the same disclosures in all communications
with the customer as are provided when the account is opened.
Proposed paragraph (c)(6)(B) provides that advertisements,
sales literature and other similar materials issued by the member
which relate exclusively to its broker/dealer services will be
deemed the materials of the member and must indicate prominently
the identity of the member providing the services. The material
may include non-prominent references to the financial institution
where the broker/dealer is conducting business in order to
identify the location where broker/dealer services are available.
In addition, such a non-prominent reference to the financial
institution may be included to disclose a material relationship
between the member and financial institution, such as that of an
investment adviser to an investment company.
Proposed paragraph (c)(6)(C) provides that advertisements,
sales literature and other similar materials jointly issued by
the member and a financial institution that discuss services or
products offered by both entities must clearly distinguish the
products and services offered by the broker/dealer from those
offered by the financial institution. The member's name must
appear prominently in the portion of the materials that describes
the broker/dealer services and products offered by the member.
That section of the materials will be deemed to be the materials
of the member. In addition, the NASD intends to review the
entire contents of all joint advertisements, sales literature and
similar material to determine if the context within which the
member's material appears complies with the NASD's advertising
rules. For example, if a member's joint advertising material
with a financial institution, when read in the context of the
joint advertisement, fails to comply with the NASD's rules, the
NASD may ask the member to seek modification of any part of the
joint advertisement or require that the member not participate in
the joint advertisement. In the event the member is unable to or
chooses not to modify the joint advertisement, the member may,
nevertheless, publish its portion of the advertisement separately
(provided the advertisement complies with the NASD's rules).
==========================================START OF PAGE 13======
The intent of subsection (c)(6) in general, and of
paragraphs (c)(6)(B) and (c)(6)(C) in particular, is to prevent
investor confusion between the products and services offered by
the broker/dealer and the products and services offered by the
financial institution, as well as to establish that advertising
and sales literature promoting the products and services of the
member conducting business on the premises of a financial
institution are subject to the regulatory oversight of the NASD.
With respect to such materials, the member must comply with all
provisions of the NASD's rules including, but not limited to, the
NASD's advertising rules, Article III, Section 35 of the Rules of
Fair Practice.
Effective Date
The NASD will announce the effective date of the proposed
rule change in a Notice to Members to be published no later than
60 days following Commission approval. The effective date will
be no more than 60 days following the publication of the Notice
to Members announcing Commission approval.
The NASD believes that the proposed rule change is
consistent with the provisions of Section 15A(b)(6) of the
Act-[11]- in that regulating the conduct of broker/dealers
on the premises of financial institutions will alleviate customer
confusion in dealing with such entities and provide a regulatory
framework for regulating such broker/dealer activities with the
result that investors will be able to make more informed
investment decisions with a better understanding of the
distinctions between the securities industry and other segments
of the financial services industry, in furtherance of the
requirement that the Association's rules promote just and
equitable principles of trade, prevent fraudulent and
manipulative acts and practices, and protect investors and the
public interest.
(B) Self-Regulatory Organization's Statement on Burden on
Competition
In response to NASD Notice to Members 94-94, a number of
commentators-[12]- noted that the proposed rule language in
that Notice required members to disclose to customers that
securities products purchased or sold by the member are not
insured by the Securities Investor Protection Corporation
("SIPC").-[13]- The commentators noted that because such
disclosures would apply only to broker/dealers operating on the
premises of a financial institution, it would unnecessarily
-[11]- 15 U.S.C. 78o-3.
-[12]- Copies of comment letters received by the
NASD on this previous
proposal are available for inspection and copying
at the NASD and in the
Commission's Public Reference Room.
-[13]- See, Notice to Members 94-94
(December 1994),
proposed subsection (c)(9)(D).
==========================================START OF PAGE 14======
discriminate among broker/dealers when customers of all
broker/dealers are subject to the same potential confusion about
the nature of SIPC insurance.-[14]- The commentators
argued that if there was going to be such a requirement at all,
the disclosures should apply to all member firms whether they
operate on the premises of a financial institution or not.
Moreover, the commentators argued that limiting SIPC disclosure
to financial institution broker/dealers is not only
anti-competitive but misleading because customers who are already
susceptible to confusion about the nature of SIPC insurance would
have their attention drawn to SIPC without a requirement that
SIPC insurance be explained to eliminate customer misperceptions.
In response to the commentators, the NASD has determined to
eliminate the SIPC disclosure requirement from the proposed rule
change, and rely instead on the disclosures that remain in the
proposed rule change which are consistent with provisions
contained in the Interagency Statement issued by the four bank
regulators. The provisions that remain in the proposed rule
change require members to disclose to customers that securities
products sold by the member (1) are not deposit insured, (2) are
not deposits of or other obligations of the financial institution
and are not guaranteed by the financial institution, and (3) are
subject to investment risks, including possible loss of principal
invested.
Some commentators have argued that the other disclosure
requirements that were contained in the proposed rules that were
published in Notice to Members 94-94 (that remain in the proposed
rule change) are discriminatory and burdensome on the class of
broker/dealers that conduct broker/dealer activities on the
premises of a financial institution. The NASD believes that the
provisions of the proposed rule change as revised are necessary
to address a specific problem (customer confusion) that the NASD
has identified in connection with the activities of members
conducted on the premises of a financial institution and has, in
general, narrowly tailored the proposed rule change to address
the problem.
Therefore, the NASD does not believe that these provisions
or any other provisions of the proposed rule change will result
in any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act, as amended.
(C) Self-Regulatory Organization's Statement on Comments on
the Proposed Rule Change Received from Members,
Participants, or Others
-[14]- See, comment letters 1, 3, 4, 7, 8,
17, 18, 22,
23, 25, 27, 37, 40, 47, 48, 50, 52, 54, 56, 63, 64,
77, 81, 84,
88, 92, 94, 99, 100, 104, 107, 109, 110, 115, 119, 121,
122, 123,
129, 130, 140, 142, 147, 153, 155, 167, 168, 169, 174,
177, 184,
186, 189, 190, 193, 197, 204, 207, 208, 212, 216, 225,
226, 227,
230, 236, 239, 240, 242, 256, 258, 266, 269, 270, 271
and 279.
==========================================START OF PAGE 15======
The proposed rule change was published for comment in Notice
to Members 94-94 (December 1994)(hereinafter referred to as
"original proposed rule change" or "original proposed rules").
284 comments were received in response thereto. Of the 284
comment letters received, 54 were in favor of the proposed rule
change, 51 of which requested modifications, 209 were opposed,
and 21 were neither in favor nor opposed.
I. General Comments.
A. Jurisdiction of the NASD in the Proposed Rules.
Several commentators, including the American Bankers
Association ("ABA"), the Bank Securities Association ("BSA"), and
the Consumer Bankers Association ("CBA"), expressed their belief
that certain provisions of the original proposed rules would
subject the activities of banks to NASD regulation.-[15]-
The commentators stated that by subjecting banks to regulation as
broker/dealers, the proposed rules fail to recognize the
exemption from broker/dealer registration that is afforded to
banks under Section 3(a)(6) of the 1934 Act. The commentators
maintained that the proposed rules also ignore the well-settled
authority of banks to provide securities brokerage services
directly to their customers under the Glass-Steagall Act, and
cited American Bankers Association v. Securities and Exchange
Commission, 804 F.2d 739 (D.C. Cir. 1986) in support.
In considering the NASD's jurisdictional reach, the ABA,
BSA, CBA, and several other commentators also argued that the
NASD has incorrectly interpreted the Securities and Exchange
Commission's no-action letter to Chubb Securities Corporation
(the "Chubb Letter"). Because the Chubb Letter was intended to
govern thrift institutions that are not exempt from broker/dealer
registration under the 1934 Act, the commentators stated that it
is inappropriate to extend the requirements of the Chubb Letter
to banks which are otherwise exempt from broker/dealer
registration by means of the device of the proposed rule
change.-[16]- Because the Chubb Letter is neither
legislation nor regulation, the commentators stated that it does
not give the NASD the authority to disregard the bank exemption
in the 1934 Act in order to regulate banks.
The NASD never intended to, and the proposed rule change
does not, extend its jurisdictional reach to banks and other
financial institutions that are not members of the Association,
nor to their employees. Accordingly, the NASD has amended
-[15]- See, comment letters 1, 5, 7, 8, 17,
19, 21, 22,
23, 27, 28, 30, 37, 40, 48, 51, 54, 56, 62, 63, 65,
67, 77, 80,
84, 90, 92, 99, 102, 107, 108, 111, 115, 118, 122, 123,
126, 127,
129, 131, 138, 141, 147, 148, 156, 158, 173, 179, 186,
188, 189,
190, 192, 195, 204, 207, 208, 209, 212, 214, 216, 225,
226, 227,
229, 233, 234, 236, 242, 266, 269, 270 and 271.
-[16]- See, comment letters 1, 8, 17, 19, 27,
80, 84, 89,
103, 115, 122, 123, 134, 138, 180, 209, 210 and 242.
==========================================START OF PAGE 16======
subsection (a) to clarify that the proposed rule change applies
only to NASD members providing broker/dealer services on the
premises of a financial institution.
Comments about the jurisdictional reach of specific
provisions of the original proposed rules are addressed in more
detail below.
B. Regulatory Duplication.
Several commentators said that the proposed rule change
duplicates existing regulations. One group of commentators
argued that the Interagency Statement issued by the financial
institution regulators on February 15, 1994, and other existing
financial institution regulations adequately address the activity
governed by the proposed rule change.-[17]- In general,
these commentators maintained that the activity addressed by the
original proposed rules should be governed by financial
institution regulations, as opposed to rules promulgated by the
SEC or the NASD. In addition, another group of commentators,
which included the ABA, BSA, and CBA, argued that some of the
provisions of the original proposed rules were redundant of
existing NASD, SEC and financial institution regulations. With
respect to NASD rules, the commentators referenced existing
branch office registration requirements, supervisory
requirements, and personnel registration/associated persons
provisions of the NASD rules. While these commentators
recognized that additional regulation of financial institution
broker/dealer-[18]- activities are appropriate, they argued
that additional regulations are already in place in the form of
the Interagency Statement and financial institution regulations,
the Chubb Letter and existing NASD rules. The commentators
believed that these guidelines, interpretations and rules
adequately address the activities that would be governed by the
-[17]- See, comment letters 1, 5, 8, 18, 21,
22, 31, 37,
38, 40, 47, 53, 54, 56, 58, 62, 65, 70, 75, 78, 91, 94,
99, 100,
101, 107, 108, 111, 126, 127, 130, 133, 138, 141, 145,
147, 151,
158, 169, 170, 179, 184, 186, 188, 190, 196, 211, 216,
218, 220,
225, 226, 227, 229, 230, 232, 236, 238, 241, 242, 245,
255, 266,
268, 269, 270, 271, 275 and 282.
-[18]- As used in this rule filing, the term
"financial
institution broker/dealer" refers to broker/dealers
affiliated
with financial institutions (as defined in the proposed
rule the
term "financial institution" means "federal and
state-chartered
banks, savings and loan associations, savings
banks, credit
unions, and the service corporations required by
law of such
institutions") or conducting business with financial
institutions
under networking arrangements. The term
"non-financial
institution broker/dealer" refers to
broker/dealers not
affiliated with, or conducting business under a
networking
arrangement with, financial institutions.
==========================================START OF PAGE 17======
proposed rules.-[19]-
The NASD agrees that some of the provisions of the original
proposed rules duplicated existing NASD rules. Accordingly, the
NASD has amended the proposed rules to eliminate such duplication
as described in more detail below. With respect to arguments
that the proposed rules duplicate the rules of other regulatory
entities (e.g., the Interagency Statement), the NASD notes that
many of the rules, policies and guidelines of other agencies do
not directly or indirectly apply to NASD members. The NASD
believes it is imperative to adopt a set of rules that
establishes clear standards of conduct governing the practices of
member firms operating on the premises of financial institutions
that are enforceable by the NASD.
C. Discriminatory Impact and Anti-Competitive Effects.
The ABA, BSA, CBA and many other commentators believe that
it is inappropriate to establish separate regulations to govern
broker/dealers operating on financial institution premises than
those in existence for other NASD members.-[20]- In
general, these commentators believe that the proposed rules
unfairly discriminate against a class of broker/dealers in
violation of Section 15A(b)(6) of the 1934 Act. The commentators
argued that the 1934 Act provides no basis for a classification
of broker/dealers based on location.
The NASD has identified circumstances associated with
conducting broker/dealer services on the premises of a financial
institution that are unique to that location and that require
rules which specifically address the conduct of members engaging
in such business. The principal circumstance noted is the
enhanced likelihood that customers of the financial institution
may not be aware of the differences between the insured
-[19]- See, comment letters 2, 7, 9, 10, 11,
17, 19, 23,
24, 25, 27, 28, 29, 30, 32, 33, 34, 35, 36, 37, 41,
42, 43, 44,
45, 48, 49, 52, 53, 55, 59, 60, 61, 63, 64, 66, 67,
68, 69, 71,
74, 76, 77, 82, 84, 87, 90, 92, 97, 102, 105, 114, 115,
116, 118,
117, 119, 120, 121, 122, 124, 128, 129, 131, 132, 148,
149, 153,
156, 157, 160, 161, 162, 163, 165, 166, 168, 169, 172,
173, 174,
175, 177, 178, 184, 189, 194, 195, 197, 201, 204, 207,
208, 209,
224, 225, 228, 231, 235, 242, 243, 246, 247, 248, 249,
250, 257,
258, 259, 261, 262, 263, 273, 279, 280, 281 and 283.
-[20]- See, comment letters 1, 2, 5, 7, 8, 9,
11, 17, 19,
21, 23, 24, 25, 27, 29, 30, 31, 32, 33, 34, 35, 36,
43, 48, 49,
52, 54, 55, 56, 59, 61, 63, 64, 66, 67, 68, 69, 71,
74, 76, 77,
82, 84, 86, 87, 88, 89, 91, 92, 97, 98, 102, 104, 105,
107, 108,
115, 116, 118, 119, 121, 122, 123, 124, 125, 126, 127,
128, 129,
131, 132, 139, 141, 142, 147, 149, 157, 159, 162, 163,
164, 165,
168, 173, 175, 178, 179, 184, 189, 194, 195, 197, 204,
208, 209,
213, 219, 218, 220, 225, 226, 227, 228, 229, 230, 236,
235, 240,
243, 242, 244, 249, 250, 257, 258, 259, 261, 262, 263,
264, 265,
273, 276, 279, 280, 281 and 283.
==========================================START OF PAGE 18======
depository products of the financial institution and the
uninsured securities products of the broker/dealer operating in
the same location. Accordingly, the NASD has determined that it
is in the public interest to propose rules to address these
unique circumstances. The NASD believes, therefore, that it is
acting in furtherance of the 1934 Act in proposing rules to
regulate the activities of broker/dealers on the premises of
financial institutions in order to address on-going problems of
customer confusion and the adequacy of the disclosures made.
These commentators also asserted their view that the NASD
has not provided statistical data to support its contention that
financial institution broker/dealers should be subject to a
"higher standard of regulation." These commentators believe that
the proposed rules are anti-competitive because, in their view,
they create an uneven regulatory scheme favoring non-financial
institution broker/dealers over financial institution
broker/dealers. The NASD does not believe that the proposed rule
change is anti-competitive in that the revised rule filed herein
is, in general, narrowly structured to address its concern of
customer confusion and investor protection.
In addition, two commentators speculated that the proposed
rules are a reflection of the NASD's ongoing battle with the
financial institution regulators.-[21]- One commentator
expressed its belief that the proposed rules are a reflection of
competitive pressures from NASD members who fear financial
institution incursions into the securities industry.-[22]-
Finally, one commentator, expressed the opinion that the rules
are punitive of members who are seeking to do business with
financial institutions.-[23]-
The NASD regrets that any commentators believe that there is
a non-regulatory motivation to the proposed rules, but there is
no basis for such comments. The NASD has responded to
commentators by modifying the rules to clarify their
jurisdictional reach, provide for greater flexibility of
compliance in certain cases, and narrow the provisions to those
most clearly applicable to addressing the potential for customer
confusion in connection with the conduct of broker/dealer
services on the premises of a financial institution.
D. Conflicting Banking and NASD Regulations.
The ICI, the OCC, the FRB, the ABA, BSA, CBA, and other
commentators expressed concern about requiring financial
institution broker/dealers to comply with potentially conflicting
-[21]- See, comment letters 127 and 258.
-[22]- See, comment letter 235.
-[23]- See, comment letter 66.
==========================================START OF PAGE 19======
requirements of the NASD and financial institution
regulators.-[24]- The ICI stated that in the absence of
functional regulation of securities activities of various
entities, the financial institution broker/dealer regulations of
the various regulators must be coordinated and harmonized in
order to reduce burdens on industry participants. These
commentators cited inconsistencies between the proposed rule
change and the Interagency Statement as an example. To the
extent that the proposed rule change differs from the Interagency
Statement, these commentators asserted that member firm
compliance will be both challenging and expensive. In addition,
a few commentators requested that the proposed rule change be
amended to provide a regulatory conflict resolution
process.-[25]-
To resolve these concerns, the NASD has amended the original
proposed rules to eliminate, to the degree possible,
inconsistencies and conflicts between the proposed rules and
existing rules and guidelines of financial institution
regulators, as discussed in more detail below. Unless regulatory
conflicts arise, which the NASD is not currently aware of, it is
unnecessary to institute a conflict resolution process. The NASD
agrees that the regulations of various regulators must be
consistent and intends to continue communications with the
financial institution regulators in order to coordinate
interpretations and application of common provisions to avoid
such problems before they develop.
E. Rationale for the New Rules.
Some commentators questioned the rationale for the proposed
rule change: the need to address issues of investor confusion and
to provide clear guidance through rules or regulations addressing
the activities of financial institution-affiliated and networking
broker/dealers operating on the premises of financial
institutions.-[26]-
As discussed above, the NASD has business practice and
investor protection concerns that it believes justify the
adoption of the proposed rules. The NASD believes the proposed
rule change is a measured response to the concerns that have been
-[24]- See, comment letters 1, 3, 4, 6, 7, 8,
9, 10, 11,
12, 16, 17, 23, 25, 27, 28, 30, 32, 47, 48, 63, 64,
65, 81, 82,
83, 84, 89, 92, 99, 100, 101, 102, 103, 104, 107, 108,
109, 110,
113, 115, 119, 120, 123, 129, 133, 135, 145, 147, 151,
153, 154,
156, 163, 166, 167, 172, 173, 180, 182, 183, 184, 188,
190, 191,
192, 196, 208, 209, 210, 211, 212, 213, 215, 216, 224,
230, 234,
237, 239, 252, 266, 236, 269, 270, 271, 272, 275, 279
and 282.
-[25]- See, comment letters 135, 146, 156 and
239.
-[26]- See, comment letters 53, 66, 67, 115,
127, 150,
185, 190, 214, 235 and 258.
==========================================START OF PAGE 20======
identified and the unique circumstances present with respect to
broker/dealers operating on the premises of a financial
institution.
F. Disparate Treatment of Investors.
Some commentators argued that financial institution
customers should not be treated as a separate class of investors
for purposes of customer protection.-[27]- These
commentators said that such disparate treatment suggests that
financial institution customers are less sophisticated than those
who deal with separate, full service, broker/dealers.
The NASD disagrees that the proposed rule change suggests
that financial institution customers are less sophisticated than
customers of full service broker/dealers. As discussed above,
the NASD has identified circumstances associated with conducting
broker/dealer services on the premises of a financial institution
that appear to be unique to that location. The principal
circumstance noted is the enhanced likelihood that customers of
the financial institution may not be aware of the differences
between the insured depository products of the financial
institution and the uninsured securities products of the
broker/dealer operating in the same location. Accordingly, the
NASD has determined that it is the public interest to propose
rules to address these unique circumstances.
II. Specific Comments
A. Applicability
Subsection (a) of the original proposed rules provided that
the section would apply exclusively to the activities of members
that conduct broker/dealer services on the premises of a
financial institution where retail deposits are taken.
The ICI, BSA, CBA, and a number of other commentators asked
that the NASD amend subsection (a) of the proposed rules to
clarify that the rules apply only to financial institution sales
activities that could confuse retail customers about the
uninsured nature of the securities products that are being
offered.-[28]- The commentators noted that the
Interagency Statement only applies to retail sales of
non-deposit investment products. The NASD believes that the
proposed rules are generally consistent with the Interagency
Statement in that they apply to all non-deposit investment
products sold by a member that is conducting business on the
premises of a retail deposit-taking institution.
The ICI, BSA, CBA, and several other commentators also
requested that the NASD clarify the phrase "on the premises" in
subsection (a) to enable members to determine the applicability
of the rules under various scenarios, such as, where a member is
-[27]- See, comment letters 10, 53, 78, 102,
115, 136,
204, 207 and 258.
-[28]- See, comment letters 11, 27, 29, 75,
84, 94, 121,
159, 167, 172, 186, 208, 210, 211 and 274.
==========================================START OF PAGE 21======
located within a financial institution building but on a separate
floor.-[29]- Commentators also asked whether the proposed
rules apply where a member leases space in a building owned by a
financial institution, but the member is not in a networking
arrangement with the financial institution nor is the member a
financial institution affiliate.
Subsection (a) has been clarified to specify that the
provisions apply only to "those broker/dealer services being
conducted by NASD members on the premises of a financial
institution where retail deposits are taken." It is intended
that, generally, broker/dealer services will be considered
separate from the retail deposit taking area of a financial
institution if the broker/dealer's facilities can be entered
without going through the retail facility of the financial
institution. Thus, the proposed rules would not apply where the
member and the financial institution are located in physically
separate and separately identified offices.
Finally, the BSA recommended that subsection (a) be amended
to include within the coverage of the proposed rule non-financial
institution broker/dealers that offer deposit-insured financial
institution products directly. The BSA expressed the opinion
that such an amendment was warranted because the investor
protection concerns addressed by the proposed rule change are
equally as relevant with respect to non-financial institution
broker/dealers that sell financial institution products.
The NASD does not agree and has no evidence that similar
investor protection concerns are present with respect to
customers of non-financial institution broker/dealers that sell
financial institution products. The NASD believes that if such
broker/dealer customers are confused about the nature and risks
of securities products they are likely to believe that none of
the products they purchase are insured when, in fact, the
customer may acquire an insured product. Thus, any customer
confusion would appear to have benign results. The NASD will,
however, continue to monitor this area.
B. Definitions
Subsection (b) of the original proposed rules included
definitions of the terms "financial institution," "networking
arrangement," "brokerage affiliate of a financial institution,"
"dual employees," and "broker/dealer services." The definitions
of "financial institution" and "broker/dealer services" are
retained in the revised rule and discussed below. The
definitions of "networking arrangement" (which has been amended
to add "brokerage affiliate arrangement") and "brokerage
affiliate of a financial institution" (which has been amended to,
simply, "affiliate") did not generate any comments and are,
therefore, discussed later in connection with the provisions
-[29]- See, comment letters 17, 21, 27, 29,
52, 63, 84,
106, 110, 115, 121, 129, 148, 167, 172, 177, 186, 192,
207, 208,
242, 245 and 260.
==========================================START OF PAGE 22======
where the terms appear. The term "dual employees" was deleted
from the proposed rule change in connection with the NASD's
revision of the original proposed rules, but not in response to a
particular comment. Therefore, it is not discussed here.
Finally, a definition of the term "confidential financial
information" was added to subsection (b). That term is discussed
below in connection with the provision where it occurs.
1. "Financial Institution."
The BSA, CBA, the FRB, and First Fidelity expressed the
concern that the definition of the term "financial institution"
set forth in paragraph (b)(1) of the original proposed rule
change inappropriately combines financial institutions and
non-financial institution entities such as savings associations
and credit unions within the same defined term.-[30]-
These commentators also expressed their view that it is
inappropriate to include service corporations within the
definition of financial institution because service corporations
themselves may be registered as broker/dealers. The NASD notes
that the language of this definition is drawn from the Chubb
Letter and is necessary for the proper operation and application
of the proposed rule. The NASD has, however, amended the
definition to ensure that it applies only to the proposed rule
and not to any other NASD rule.
The FRB also suggested that the NASD consider expanding the
definition of financial institution to include foreign financial
institutions given that a number of foreign financial
institutions have established branches in the United States, and
several of these institutions have broker/dealer affiliates. The
NASD believes that it is not appropriate to include within the
scope of the rule foreign financial institutions not required to
register as a bank, savings and loan or credit union.
2. "Broker/dealer Services"
The ABA, BSA, CBA , and several commentators expressed
concerns about the scope of the term "broker/dealer services" as
defined in paragraph (b)(4) of the original proposed rule
change.-[31]- The commentators stated that the proposed
definition improperly limits the activities of unregistered
financial institution employees. Accordingly, the commentators
have recommended that the definition be amended to state that
nothing in the proposed rules is intended to limit the ability of
financial institutions and their employees to engage in
securities transactions pursuant to the exemption from
broker/dealer registration that is granted to banks by Section
3(a)(6) of the 1934 Act.
Further, the ABA and BSA raised the concern that it was
-[30]- See, comment letters 27, 84, 103 and
199.
-[31]- See, comment letters 4, 8, 17, 19, 21,
25, 27, 28,
29, 54, 62, 63, 80, 84, 106, 115, 121, 131, 129, 192,
173, 186,
207, 208, 242, 267, 260, and 281.
==========================================START OF PAGE 23======
unclear whether or not the proposed rule is intended to reach
investment banking services offered by bank trust departments
where services are offered by individuals who hold NASD licenses.
Because the term "investment banking and securities business" has
a settled meaning within the broker/dealer industry, the BSA
recommends that the NASD adopt the "investment banking"
definition in paragraph (h) of Article I of the NASD By-Laws to
address the problems raised with regard to the proposed
broker/dealer services definition.
In this regard, it was never the intent of the NASD to
extend its jurisdictional reach to banks and other financial
institutions. In response to these comments, the NASD sought to
clarify its intent by amending the definition of "broker/dealer
services," to reference the definition of "investment banking and
securities business" contained in Article I, Paragraph (l) of the
NASD By-Laws. The definition in Article I of the By-Laws
excludes investment banking and securities activities carried on
by banks, including bank trust departments. In addition, as
discussed above, the NASD has amended subsection (a) to clarify
that the proposed rule change applies only to broker/dealer
services conducted on the premises of a retail-deposit-taking
financial institution. The NASD believes that these changes
clarify that the proposed rule change does not seek to regulate
the securities activities of banks that are exempt from
broker/dealer registration.
C. Specific Provisions Relating to Activities of Members
Operating on the Premises of a Financial Institution.
1. Physical Location
Subsection (c)(1) of the original proposed rules provided
that a member's broker/dealer services shall be conducted in a
physical location distinct from the area where the financial
institution's retail deposits are taken. Several commentators
requested clarification about the definition of "where retail
deposits are taken" in subsection (c)(i) and to the term
"deposit-taking area"-[32]- used in other provisions (i.e.,
is it the teller area of a financial institution?)
Many commentators criticized subsection (c)(i) as not
providing adequate flexibility for financial institution
-[32]- See, comment letters 6, 8, 12, 16, 17,
27, 29, 30,
52, 58, 63, 64, 77, 80, 83, 86, 110, 129, 153, 155,
167, 177,
186, 193, 207, 208, 213, 239, 244, 260 and 282.
==========================================START OF PAGE 24======
locations with severe physical constraints.-[33]- These
commentators asked the NASD to address the problem by adopting
the Interagency Statement standard which, in relevant part
states, "in the limited situation where physical considerations
prevent sales of non-deposit products from being conducted in a
distinct area, the institution has a heightened responsibility to
ensure appropriate measures are in place to minimize customer
confusion."-[34]-
Finally, the BSA and four other commentators asked whether
dual employees would be required to have two separate offices for
conducting activities on behalf of the financial institution and
the broker/dealer.-[35]- These commentators maintained
that customers could be confused if a dual employee were required
to lead customers back and forth between two locations within the
financial institution. To address this potential for customer
confusion, the BSA suggested that the proposed rule change be
amended to permit the use of one desk for deposit and non-deposit
activities. Indeed, the BSA expressed the view that
appropriately qualified dual employees should be permitted to
offer customers a "menu" of retail financial products, including
insured deposits and uninsured investment products, from the same
location.
In response to the commentators, subsection (c)(1) of the
proposed rule change was revised to require the member to operate
in a distinct area "wherever possible," consistent with the
Interagency Statement. In addition, the proposed rule change
has been amended to require that the member "distinguish" its
broker/dealer services from the services of the financial
institution as opposed to "segregating" its services as required
by the original proposed rule change.
With regard to the commentators' concerns regarding
consistency in regulation, the NASD has amended the physical
location and signage requirements and the proposed risk
disclosures to ensure consistency with the Interagency
Statement's standards for these matters. (See, new paragraphs
(c)(1) and (c)(4), respectively.) These amendments are also
discussed in greater detail below.
-[33]- See, comment letters 1, 4, 8, 11, 16,
17, 19, 21,
25, 26, 27, 29, 30, 31, 47, 54, 76, 84, 88, 90, 94,
103, 107,
112, 118, 119, 121, 123, 127, 129, 130, 131, 140, 153,
154, 156,
166, 167, 176, 181, 182, 184, 189, 192, 193, 196, 204,
208, 210,
212, 215, 230, 233, 234, 237, 242, 244, 255, 267,
276, 279 and
282.
-[34]- See, comment letters 27, 40, 86, 96,
181, 208,
239, 245, 256 and 283.
-[35]- See comment letters 27, 110, 182,
193, 207 and
233.
==========================================START OF PAGE 25======
2. Signage
Subsection (c)(2) of the original proposed rule change
stated, "in no event shall signs regarding the broker/dealer
services appear in the deposit-taking area." Many commentators,
including the ABA, ICI, BSA, and CBA, asked whether the proposed
rules would prohibit signage in the teller window or the lobby
areas.-[36]- The commentators argued that this requirement
could interfere with directional signage pointing toward the
location of the broker/dealer, ordinary brochure stands, mounted
lists of affiliated companies, and other signage relating to the
general availability of products and services of the
broker/dealer. Rather than create confusion, the BSA argued
that directional signs can help avoid customer confusion by
clarifying that a deposit-taking area, such as a teller window,
is not the place to obtain securities products. These
commentators asserted that broker/dealer signage with appropriate
disclosures should be permitted to appear anywhere on the
financial institution's premises.
Other commentators expressed concerns about the potential
impact of the signage requirements in the case of small financial
institutions.-[37]- These commentators noted that signage
restrictions are particularly difficult for small financial
institutions and small branch offices to deal with because
practically all public areas could be regarded as deposit-taking
areas. Further, the commentators noted that small branches may
not reserve one desk solely for investment services thus
preventing the segregation desired by the original proposed
rules. The commentators also observed that signage restrictions,
when combined with the physical location requirements, would
prevent one-desk branch locations. Accordingly, these
commentators recommended that the proposed rules be amended to
permit signage that would facilitate dual usage of a service desk
by broker/dealer and financial institution employees.
One commentator stated that, in its view, the proposed
signage restrictions would interfere with the financial
institution's commercial speech which is protected by the First
Amendment of the U.S. Constitution.-[38]- This commentator
also stated that this interference with the financial
institution's rights resulted in the NASD's assertion of
jurisdiction over the financial institution.
-[36]- See, comment letters 4, 8, 9, 10, 11,
17, 21, 23,
25, 27, 28, 30, 48, 59, 81, 83, 84, 104, 115, 119, 120,
121, 123,
129, 134, 140, 154, 156, 167, 170, 192, 204, 207, 208,
213, 232,
233, 236, 242, 244, 245, 276, 279 and 281.
-[37]- See, comment letters 4, 12, 21, 29,
40, 47, 52,
54, 107, 113, 133, 156, 167, 181, 184, 196, 198, 210,
234, 242,
255, 256, 279 and 282.
-[38]- See, comment letter 30.
==========================================START OF PAGE 26======
The NASD disagrees and does not believe that the proposed
rule change infringes on the limited First Amendment protection
on commercial speech because the U. S. Constitution acts as a
restraint on governmental action and the First Amendment's free
speech guarantee is a limitation on Congress' ability to enact
laws abridging freedom of speech. The NASD's actions as a
private, non-governmental, securities industry, self-regulatory
organization (actions that include adopting rules or enforcing
standards of business conduct) are not governmental actions
subject to Constitutional restraint. Nevertheless, the NASD
applies a standard of fundamental fairness in its dealings with
its members and its rules, including the rule change proposed
herein, are narrowly tailored to achieve legitimate regulatory
purposes. The NASD also notes that even if the NASD's regulatory
proposals were constrained by the Constitutional protection on
commercial speech, those protections are limited to the extent
that reasonable regulations of commercial speech are necessary to
protect the public interest and the proposed rule change is a
reasonable regulation of commercial speech.
Nevertheless, in response to the commentators, the NASD has
amended the proposed rule change to delete the separate provision
relating to signage, including the provisions prohibiting signs
regarding broker/dealer services in the financial institution's
deposit-taking area. The requirement in the deleted provision
that a member clearly display its name in the area where
brokerage services are being conducted has been consolidated with
Subsection (c)(1) of the proposed rules. Thus, as long as
signage meets the other requirements of the proposed rule change,
as well as existing NASD rules requiring accurate information
that is not misleading under the circumstances in which it is
used, there are no other limitations.
3. Branch Office Registration Requirements
Subsection (c)(3) of the original proposed rules restated an
already existing NASD rule requirement that the member must
register as a branch office any of its offices which operates on
the premises of a financial institution. Most commentators,
including, among others, the ICI, ABA, BSA, and CBA, asked that
the provision be amended to exempt from branch registration
requirements locations where a broker/dealer meets a client in a
financial institution office for purposes of customer
convenience, but where the financial institution office is not
permanently staffed by the NASD member, nor is the location held
out as a branch of the NASD member.-[39]- These
commentators expressed significant concerns regarding the cost of
registering locations serviced by so-called "circuit riders" if
-[39]- See, comment letters 3, 7, 8, 14, 15,
19, 23, 27,
28, 29, 30, 32, 37, 39, 40, 48, 54, 63, 75, 82, 84,
91, 96, 101,
104, 108, 109, 110, 115, 119, 121, 125, 127, 129, 140,
144, 145,
166, 167, 173, 177, 181, 189, 192, 204, 205, 207, 208,
213, 215,
230, 236, 239, 244, 251, 256, 264 and 267.
==========================================START OF PAGE 27======
the NASD does not amend the rule to provide an exception for
meetings between a member's registered representative and
financial institution customers that occur on an appointment
basis at financial institutions.
In addition, the BSA expressed the opinion that, if the NASD
has determined to publish an interpretation of what is a "branch
office" under Section 27(g)(2) of the Rules of Fair Practice, it
should be done in a uniform manner applicable to all NASD members
and not as a formal NASD rule applicable only to financial
institution broker/dealers. The ABA and the CBA also argued that
there was no justification for treating financial institution
branches any differently than other retail outlets for purposes
of branch office registration.
Further, commentators observed that requiring registration
of every location at which a representative meets with a customer
could limit the ability of members to service customers where
states do not permit a registered representative to work out of
more than one registered location.-[40]-
Finally, the Independent Bankers Association of America
("IBAA") and two other commentators argued that the branch office
registration requirements would result in compliance problems
with respect to the books and records maintained at the financial
institution location.-[41]- To address this concern, the
IBAA asked that the rules be amended to provide limited relief to
allow financial institution broker/dealers to maintain books and
records at a more central location, for example, the main office
of the financial institution.
The NASD appreciates the concerns expressed by these
commentators and, accordingly, has amended the proposed rules to
delete the branch office registration requirements and, instead,
rely on the branch office registration requirements currently in
effect under existing NASD rules. Therefore, members doing
business on the premises of a financial institution will be
expected to comply with the branch office requirements in the
NASD's rules that currently apply to all other members.
4. Networking and Brokerage Affiliate Agreements
Subsection (c)(4) of the original proposed rules provided
that relationships between financial institutions and members
(whether network or affiliate) be governed by an agreement that
sets forth the responsibilities of the parties.
Regulatory Access - Paragraph (c)(4)(A) provided that the
written agreement between the broker/dealer and the financial
institution, among other things, specify that the SEC and the
NASD must be granted access to the financial institution premises
to inspect the books and records of the broker/dealer and other
relevant information maintained by the member with respect to its
broker/dealer services. With respect to this requirement, the
-[40]- See, comment letters 23, 108 and 236.
-[41]- See, comment letters 101, 122 and 154.
==========================================START OF PAGE 28======
North American Securities Administrators Association Inc.
("NASAA") and the State of Iowa urged the NASD to amend the
provision to grant such access to state regulators. -[42]-
The NASD formulated this provision to be consistent with the
Chubb Letter. It is believed that state regulators currently
have appropriate authority to have access to the premises of
financial institutions to inspect the books and records of
broker/dealers. The BSA stated that the SEC will use this right
of access provision to indirectly regulate any desired activity
of a financial institution.-[43]- The NASD believes that
the concerns of the BSA are more appropriately directed to the
SEC.
Periodic Reviews - Paragraph (c)(2)(C) of the original
proposed rules required that the financial institution agree to
permit the member to conduct periodic reviews to assure that the
financial institution and its unregistered employees comply with
the limits on their activities with respect to securities
transactions and non-deposit broker/dealer services. One
commentator stated that the provision could be interpreted to
require that an unaffiliated network member be granted access to
the books and records of its partner financial institution for
periodic reviews.-[44]- This commentator also stated that,
if the financial institution and the networking member compete
in several lines of business, the requirement would have had the
net effect of discouraging a financial institution's
participation in networking arrangements in order to avoid
disclosing confidential business information.
Further, with regard to a member conducting periodic reviews
to assure that the financial institution and its unregistered
employees comply with the limits on their activities, the ICI,
BSA, CBA, and several other commentators argued that it is
inappropriate for an NASD member to serve in the role of an
auditor. They argued that this responsibility is more
appropriately handled by the financial institution.-[45]-
The commentators also asserted that the financial institution
should be responsible for conducting its own supervision,
training, investigations, and compliance as it relates to the
activities of its own employees who are not registered with a
broker/dealer. The commentators stated that it is impractical
for a small number of broker/dealer employees to monitor the
-[42]- See, comment letters 203 and 254.
-[43]- See, comment letter 27.
-[44]- See, comment letter 211.
-[45]- See, comment letters 1, 4, 10, 17, 21,
23, 27, 28,
30, 37, 48, 59, 62, 63, 77, 80, 84, 104, 107, 121, 128,
134, 140,
142, 148, 153, 156, 181, 186, 207, 208, 234, 236,
242, 274, 281
and 282.
==========================================START OF PAGE 29======
activities of all unregistered financial institution employees.
Additionally, one commentator asked what actions a member
could take against a financial institution if it believes the
financial institution has not complied with the limits on its
activities with respect to securities transactions and
non-deposit broker/dealer services.-[46]- Another
commentator argued that the contractual obligations of proposed
Paragraph (c)(4)(C) would create broker/dealer liability for
financial institution employees over whom the broker/dealer has
no control. -[47]-
The ICI urged the NASD to revise the paragraph to require
that members only obtain a commitment from the financial
institution such that the financial institution agrees that it
will promulgate and implement procedures reasonably designed to
ensure compliance with the limits on the activities of
unregistered financial institution employees rendered in
connection with the member's broker/dealer services.
In response to the foregoing comments, the NASD has amended
the proposed rule change to delete paragraph (c)(4)(C).
Dual Employees - Paragraph (c)(4)(D) of the original
proposed rules provided that the written networking or brokerage
affiliate agreement must require that any dual employee who is
suspended from association with the member, or who the SEC, the
NASD, or any other regulatory or self-regulatory organization
bars or suspends from association with the member or any other
broker/dealer, will be terminated or suspended, respectively,
from all securities activities conducted directly by the
financial institution. Many commentators strongly objected to
the jurisdictional reach of this provision.-[48]- The
commentators stated that financial institutions must retain the
discretion to determine what situations justify an employee's
termination or suspension.
One commentator stated that there may be a multitude of
NASD, SEC or other regulatory reasons for which an employee may
be suspended. The commentator maintained that some of these
reasons may by regulation require a financial institution to
suspend or terminate the employee's activities. However, the
financial institution may not in the exercise of its independent
judgment consider certain other reasons as justification for
barring the employee from engaging in securities activities
-[46]- See, comment letter 59.
-[47]- See, comment letter 30.
-[48]- See, comment letters 1, 4, 10, 17, 21,
23, 27, 28,
30, 37, 48, 59, 62, 63, 77, 80, 84, 104, 107, 121, 128,
134, 140,
142, 148, 153, 156, 181, 186, 207, 208, 234, 236,
242, 274, 281
and 282.
==========================================START OF PAGE 30======
conducted by the financial institution.-[49]-
Further, one commentator stated that requiring the
financial institution to agree to terminate or suspend employees
would result in the creation of a "black list" of employees that
could potentially expose the financial institution to lawsuits by
such black-listed employees.-[50]- Rather than adopting
the proposed contractual agreement of the financial institution
to terminate or suspend employees, one commentator proposed that
financial institutions be provided access to the Form U-5 for
terminated employees.-[51]-
In response to the foregoing comments, the NASD has amended
the proposed rule change to delete paragraph (c)(4)(D).
Competition - Paragraph (C)(4)(E) of the original proposed
rules required that a contractual agreement with the financial
institution provide that "unregistered employees of the financial
institution will not receive any compensation, cash or non-cash,
that is based on the effectiveness or success of referrals. . . .
" Many commentators, including the ABA, BSA and OCC, urged the
NASD to define the terms "success" and "effectiveness of
referrals" arguing that a prohibition based on the effectiveness
of sales rather than a transactional nexus is too
ambiguous.-[52]- The commentators asked how the provision
would apply where the financial institution provides payment for
referrals that result in an appointment with a broker/dealer
rather than a transaction.
The ABA also stated that a standard based on the success or
effectiveness of referrals is stricter than existing NASD and
financial institution standards that permit a referral payment
where it is not tied to the success of a sale or opening of a
broker/dealer account.-[53]-
Other commentators, including the ABA and the BSA,
challenged the NASD's authority to regulate the compensation paid
by a financial institution to its employees through contractual
obligations of an NASD member.-[54]- These commentators
-[49]- See, comment letter 21.
-[50]- See, comment letter 128.
-[51]- See, comment letter 28.
-[52]- See, comment letters 7, 16, 19, 23,
27, 28, 37,
48, 59, 84, 86, 104, 107, 108, 110, 115, 129, 140, 142,
173, 181,
183, 186, 192, 236, 240, 244, 260, 274 and 282.
-[53]- See, comment letter 8.
-[54]- See, comment letters 1, 11, 17, 19,
28, 62, 63,
64, 83, 84, 104, 115, 121, 128, 131, 138, 153, 192,
202, 208,
216, 224, 233, 251, 281 and 282.
==========================================START OF PAGE 31======
stated that, as a general matter, financial institution
regulations provide adequate investor protection safeguards with
regard to the financial institution's payment of referral fees
and, accordingly, NASD regulation of such payments was not
required.
In response to the foregoing comments, the NASD has amended
this provision to prohibit compensation that is conditioned on
whether a referral results in a transaction, which is consistent
with comparable provisions of the Interagency Statement. See,
paragraph (c)(2)(B) of the proposed rule change.
Notification - Paragraph (c)(5) of the original proposed
rules provided that the networking or brokerage affiliate
agreement must require that the member notify the financial
institution if any dual employee who is associated with the
member is terminated for cause by the member. Three commentators
asserted that the provision would lead to civil penalties because
the disclosure of the reasons for a suspension and/or termination
raises privacy issues which, absent permission from the
associated person, may subject the broker/dealer to civil
liabilities.-[55]- One commentator suggested that should
the NASD determine to address the civil liability issues, it
would be more appropriate to require the broker/dealer to notify
the financial institution that it would no longer utilize the
services of a financial institution employee and, thereafter,
direct the financial institution to review the employee's Form U-
5.-[56]-
The NASD has determined to retain this provision as
paragraph (c)(2)(C) substantially unchanged. The NASD believes
the financial institution should have this information in order
for it to review and determine its own regulatory obligations
with respect to the terminated individual.
5. Personnel Registration/Associated Person
Subsection (c)(6) of the original proposed rule change
provided that broker/dealer services offered by the member could
be provided only by persons associated with the member, except
that unregistered dual employees of the member and financial
institution could provide "clerical and ministerial assistance."
Several commentators requested clarification of the phrase
"clerical and ministerial assistance,"-[57]- and observed
that limiting employees activities to "clerical and ministerial"
duties could be viewed as ignoring the exemption from
broker/dealer registration afforded banks under Section (3)(a)(6)
of the 1934 Act. In addition, the commentators asked that
subsection (c)(6) be clarified to focus on the participation of
-[55]- See, comment letters 28, 40 and 177.
-[56]- See, comment letters 28.
-[57]- See, comment letters 6, 16, 27, 64, 84,
104, 110,
119, 130, 142, 172, 192, 206, 208, 213, and 233.
==========================================START OF PAGE 32======
unregistered financial institution employees in a member's sales
activities, rather than participation of unregistered financial
institution employees in a financial institution's direct sales
efforts.
In response to the comments, the NASD has determined that
subsection (c)(6) is redundant of other provisions of the
securities laws and, therefore, is unnecessary. Bank employees
may engage in direct securities activities pursuant to the
exemption from broker/dealer registration contained in Section
3(a)(6) of the 1934 Act, subject only to the restrictions on bank
securities activities in federal banking law. To the extent the
employees of all other types of financial institutions engage in
securities activities, they must be registered as associated
persons of a registered broker/dealer. Accordingly, the NASD has
amended the proposed rule change to delete subsection (c)(6).
6. Compensation of Registered/Unregistered Personnel
Paragraph (c)(7)(A) of the original proposed rules provided
that transaction-related compensation of a member's registered
representatives, including dual employees, must be determined
solely by the member. In response, the BSA, CBA, and several
other commentators have advised the NASD that this requirement
conflicts with existing financial institution regulations that
require the financial institution to ensure that compensation
does not influence sales of unsuitable products.-[58]- In
addition, commentators maintained that this provision would
compromise the ability of a financial institution to meet its
overall company goals.
Paragraph (c)(7)(B) of the original proposed rule provided
that employees of the financial institution who are not
registered with the NASD member may not receive any compensation
from the member, cash or non-cash, in connection with, but not
limited to, the referral of customers of the financial
institution to the member. Many commentators, including the ICI,
BSA, CBA, and the FRB, argued that the provision is inappropriate
and unwarranted because referral fees provide an appropriate
incentive to increase customer awareness of all types of deposit
and non-deposit products that are available to financial
institution customers.-[59]- Moreover, commentators
-[58]- See, comment letters 7, 10, 11, 16,
17, 21, 22,
23, 25, 26, 27, 28, 37, 47, 48, 88, 94, 100, 107, 108,
110, 112,
121, 122, 123, 129, 134, 135, 140, 147, 153, 154, 166,
186, 188,
190, 192, 207, 233, 234, 236, 237, 239, 240, 242, 260,
266, 269,
270, 271 and 282.
-[59]- See, comment letters 1, 3, 7, 8, 16,
18, 21, 22,
23, 25, 26, 27, 28, 29, 40, 44, 46, 59, 63, 75, 84,
88, 92, 93,
95, 98, 99, 100, 108, 111, 112, 115, 121, 123, 127,
129, 130,
135, 142, 143, 147, 153, 156, 166, 167, 168, 172, 188,
189, 191,
(continued...)
==========================================START OF PAGE 33======
argued that banning such referral payments would create a
competitive disadvantage for financial institution broker/dealers
because members who do not operate on the premises of a
financial institution have more leeway under SEC no-action
letters and enforcement decisions in providing compensation to
unregistered persons.
The commentators also argued that the referral fees
prohibition is inconsistent with the Interagency Statement and
the Chubb No-action Letter, among others. Finally, the
commentators stated that the prohibitions regarding referral fees
are inconsistent with the NASD's long-standing position that
"one-time fees not tied to the completion of a transaction or the
opening of an account" are permitted.-[60]- Several
commentators were also confused about whether the financial
institution and the broker/dealer were both prohibited from
paying referral fees to unregistered employees.-[61]-
Paragraph (c)(7)(B) previously published for comment
referred only to compensation paid by an NASD member. It would
not have regulated the compensation a financial institution may
provide to its own employees. The NASD's longstanding position
-[59]-(...continued)
193, 204, 207, 210, 212, 213, 214, 230, 232, 235, 236,
239, 240,
244, 252, 255, 256, 265, 266, 269, 270, 272, 277, 279
and 284.
-[60]- In support of its argument that
paying referral
fees is acceptable and consistent with the NASD's
long-standing
position, the ICI cites NASD Notice to Members
89-3 (January
1993), in which the NASD proposed, but never adopted,
a rule to
restrict the payment of referral fees. The rule
change proposed
in NTM 89-3 would have permitted the payment by a
member of a
small fixed fee for a referral where the payment is
occasional,
not part of a practice of such payments to the
recipient, not
determined by the outcome of the referral, and
where the
recipient does not regularly engage in activity
that might
reasonably be expected to result in continued
referrals.
The NASD believes the ICI is incorrect in its
assertion that
paying referral fees is acceptable and consistent with
the NASD's
longstanding position. Quite to the contrary, the
rule change
proposed herein is consistent with that position.
The rule
proposed in NTM 89-3 was a codification of the
NASD's position
that the payment of referral fees is not permitted,
except in
very narrow circumstances. Permitting the payment
of referral
fees for activity described in this proposed rule
change would
not have met the exception proposed in NTM 89-3.
-[61]- See, comment letters 4, 9, 14, 15, 16,
18, 21, 27,
29, 30, 39, 50, 64, 77, 80, 83, 84, 85, 86, 92, 94,
107, 108,
109, 122, 125, 144, 145, 152, 154, 155, 187, 203, 204,
205, 207,
213, 215, 220, 221, 222, 223, 237, 242, 258, 267, 275
and 277.
==========================================START OF PAGE 34======
regarding referral fees has been that if one-time payments by a
member to an unregistered individual occur on a regular, on-going
basis, the recipient is required to register as an associated
person.-[62]- In addition, an NASD member may not do
indirectly what it is prohibited from doing directly, i.e., an
NASD member may not compensate employees of the financial
institution for referrals through payments made directly to the
employee or by payments directed in the first instance to the
financial institution.
The NASD also believes the commentators misunderstand the
meaning of the "one-time payment exception" that has previously
been the policy of the NASD and was reflected in the provision
published for comment. As stated above, the exception does not
permit a series of "one-time payments" because such a series of
payments would become part of the employee's regular course of
business, a circumstance that would require registration. To
meet the requirements of the exception that has previously been
the policy of the NASD, a payment must be a singularly unusual
event; i.e., so infrequent that it cannot be regarded as part of
the regular business or activity of the employee.
In response to the comments received, however, the NASD has
substantively amended the provisions of the original proposed
rule change by clarifying and consolidating them into a single
provision, subsection (c)(3), that prohibits a member from
providing compensation to the employees of a financial
institution who are not registered as associated persons of a
member in connection with, but not limited to, locating,
introducing, or referring customers of the financial institution
to the member.
7. Supervision and Responsibility
Paragraph (c)(8)(A) of the original proposed rules provided
that a designated principal of the member shall supervise
registered personnel at the member's location at the financial
institution. Several commentators urged the NASD to amend this
provision to clarify that the designated principal deemed to be
responsible for supervising registered personnel at the member's
location at the financial institution is not required to be
physically present at the financial institution
location.-[63]- Further, commentators argued that the
provision duplicates existing supervisory requirements applicable
to all NASD members, as set forth in Article III, Section 27 of
the Rules of Fair Practice.
The ICI argued that the NASD should delete paragraph
(c)(8)(C) of the original proposed rules which required a member
to supply financial institutions with written procedures that
---------FOOTNOTES----------
-[62]- See, NASD Guide to Rule Interpretations, 1994
Net Capital
and Customer Protections Rules, p. 108.
-[63]- See, comment letters 17, 21, 27, 28,
64, 77, 121,
129, 138, 140, 156, 177, 181, 192, 234, 242, 245, 267,
and 276.
==========================================START OF PAGE 35======
specify the limits of the permissible activities of unregistered
persons.-[64]-
In response to the commentators, the NASD has determined to
delete paragraph (c)(8) of the original proposed rules in its
entirety as generally redundant of the member's obligations under
already existing NASD rules.
8. Customer Disclosure and Written Acknowledgment
Subsection (c)(9) of the original proposed rules required a
member to obtain a separate written acknowledgment at the time an
account is opened that the securities products purchased or sold
by the member through offices located on the premises of a
financial institution: (1) are not insured by the FDIC; (2) are
not deposits or other obligations of the financial institution
and are not guaranteed by the financial institution; (3) are
subject to investment risks, including possible loss of the
principal invested; and, (4) are not insured by the Securities
Investor Protection Corporation ("SIPC") as to the loss of
principal amounts invested.
Several commentators argued that the disclosures required in
the proposed separate written acknowledgment should be made by
all broker/dealers because, as the BSA asserted, investors who
purchase securities through non-financial institution
broker/dealers would benefit equally from these required
disclosures, especially non-financial institution broker/dealers
offering insured products.-[65]-
Other commentators stated that a requirement to obtain
written acknowledgment of the disclosures prior to conducting
business with a customer who opens an account by telephone would
have an adverse impact on members that service the financial
institution s customers because many of these accounts are opened
by telephone and written documentation is usually sent to the
customer by the broker/dealer after the account is opened. These
commentators proposed that the rule be amended to permit a
member's registered representative to state the disclosure over
the telephone and subsequently forward the written documentation
for execution.-[66]-
Some commentators, including the CBA and BSA, opposed the
concept of requiring a "separate" written acknowledgment of the
required disclosures based on their belief that the Interagency
Statement permits these disclosures to appear in the customer
agreement or account application.-[67]- Accordingly, the
-[64]- See, comment letter 167.
-[65]- See, comment letters 1, 6, 17, 21,
27, 61, 94,
104, 136, 173, 189, 217, 219 and 230.
-[66]- See, comment letters 17, 172 and 242.
-[67]- See, comment letters 10, 27, 84, 101,
102, 104,
115, 166, 172, 173, 192, 207, 212, 239, 250, 279 and
282.
==========================================START OF PAGE 36======
BSA, the CBA, and other commentators proposed that the
disclosures be a part of a new account form/account
application.-[68]-
A number of the commentators, including the OCC, expressed
concerns about competing disclosures of the NASD and financial
institution regulators, especially when the expenses associated
with printing disclosure documents are considered.-[69]-
One commentator, Citicorp Investment Services, noted that
compliance costs for the Interagency disclosures were in excess
of one million dollars, yet the proposed rule change would
require existing materials to be reprinted.-[70]- The
commentators urged the NASD to coordinate with financial
institution regulators to adopt one standard disclosure.
Many commentators, including the ICI, OCC, and the FRB, said
that the proposed SIPC disclosure would cause greater confusion
than existing disclosure requirements.-[71]- The
commentators argued that the SIPC disclosure is confusing because
it stands alone with no explanation of SIPC. The OCC and a
number of other commentators recommended that, in the
alternative, the NASD should amend the proposed rule change to
require the SIPC disclosure only where sales activities include
representations regarding SIPC. A number of commentators also
expressed their view that the proposed SIPC disclosure is
technically incorrect because the loss of principal amounts
invested is protected where a broker/dealer becomes
insolvent.-[72]- One commentator suggested that the SIPC
disclosure be amended to state that "losses due to market
fluctuation are not protected by SIPC."-[73]-
A large number of commentators also noted that the proposed
SIPC disclosures discriminate among broker/dealers. They argued
that if the SIPC disclosure requirement is to be adopted at all,
-[68]- See, comment letters 10, 27, 84, 101,
192 and 239.
-[69]- See, comment letters 3, 4, 11, 28, 40,
50, 63, 64,
67, 75, 81, 104, 115, 120, 121, 128, 129, 130, 180,
208, 213,
234, 237, 252 and 279.
-[70]- See, comment letter 67.
-[71]- See, comment letters 1, 7, 9, 11, 12,
16, 19, 30,
37, 50, 54, 75, 76, 80, 81, 84, 90, 92, 93, 103, 107,
112, 113,
115, 121, 122, 123, 129, 137, 140, 143, 167, 172, 173,
177, 183,
204, 207, 210, 211, 224, 230, 234, 236, 244, 252 and
282.
-[72]- See, comment letters 20, 21, 22, 25,
27, 75, 76,
85, 94, 99, 104, 133, 137, 142, 147, 148, 156, 167,
168, 170,
178, 183, 186, 188, 190, 196, 210, 211, 216, 233, 266,
269, 270,
271 and 272.
-[73]- See, comment letter 233.
==========================================START OF PAGE 37======
the disclosures should apply to all member firms whether
operating on financial institution premises or not; limiting SIPC
disclosure to financial institution broker/ dealers is not only
anti-competitive but misleading.-[74]-
In response to these comments, the NASD has determined to
delete the proposed SIPC disclosure in paragraph (c)(9)(D). The
required disclosure set forth in subsection (c)(4) of the
proposed rule change is now substantively identical to that
contained in the Interagency Statement.
9. Solicitation
Subsection (c)(10) of the original proposed rules prohibited
members from using confidential financial information maintained
by the financial institution to solicit customers for its
broker/dealer services.-[75]- Many of the commentators
argued that, to the extent there are special concerns when a
financial institution provides confidential financial
information, the concerns are properly the subject of financial
institution regulation and existing federal privacy laws, not
NASD rulemaking.
Some commentators who opposed the limitations advised the
NASD that prohibitions on a member's use of confidential
financial information should apply equally to all broker/dealers.
The commentators argued that there is no public policy reason why
customer information possessed by affiliates of non-financial
institution broker/dealers on real estate holdings, consumer
finance loans, insurance, or other financial matters should be
treated differently than customer information provided by a
financial institution.
The commentators asked, however, if the NASD determines to
retain this aspect of the proposed rule change, that the
provision be amended to allow a member's use of confidential
financial information where a customer has approved of such use.
In addition, the OCC recommended that the provision be amended to
-[74]- See, comment letters 1, 3, 4, 7, 8,
17, 18, 22,
23, 25, 27, 37, 40, 47, 48, 50, 52, 54, 56, 63, 64,
77, 81, 84,
88, 92, 94, 99, 100, 104, 107, 109, 110, 115, 119, 121,
122, 123,
129, 130, 140, 142, 147, 153, 155, 167, 168, 169, 174,
177, 184,
186, 189, 190, 193, 197, 204, 207, 208, 212, 216, 225,
226, 227,
230, 236, 239, 240, 242, 256, 258, 266, 269, 270, 271
and 279.
-[75]- See, comment letters 1, 3, 8, 9, 10,
11, 12, 16,
17, 18, 19, 21, 22, 25, 26, 27, 28, 29, 30, 37, 40,
41, 44, 46,
52, 59, 60, 61, 62, 63, 64, 67, 72, 73, 75, 76, 82,
83, 84, 86,
88, 90, 91, 92, 95, 99, 100, 102, 104, 106, 110, 111,
112, 113,
115, 119, 121, 122, 123, 127, 129, 130, 131, 133, 136,
137, 138,
141, 142, 145, 147, 153, 154, 156, 166, 167, 168, 169,
170, 172,
173, 174, 176, 177, 178, 180, 183, 184, 186, 189, 190,
191, 192,
193, 197, 202, 204, 208, 209, 210, 211, 212, 216, 220,
224, 225,
226, 227, 230, 232, 233, 234, 236, 237, 239, 240, 242,
244, 255,
256, 258, 265, 266, 272, 274, 278, 281, 282 and 294.
==========================================START OF PAGE 38======
require members to establish policies and procedures regarding
the use of confidential financial information instead of banning
the use of such information. Many commentators asked that the
term "confidential financial information" be defined, if the NASD
retains the provision in the proposed rule change.-[76]-
Finally, some commentators asked how a member could restrict
the use of confidential information where dual employees have
access to the information.-[77]- Another commentator
asked that the rule be amended to permit the financial
institution to control abusive use of confidential financial
information where a wholly-owned broker/dealer subsidiary is
involved.-[78]- Another commentator also urged that
sharing confidential information should be permitted where the
financial institution and the broker/dealer are
affiliates.-[79]-
In response to the comments, the proposed rule change has
been amended in subsection (c)(5) under a new heading entitled
"Use of Confidential Information" to allow the use of
confidential financial information with the prior written
approval of the customer. In addition, a definition of the term
"confidential financial information" has been added to the
proposed rule change which provides that information will not be
regarded as confidential if it can be obtained from unaffiliated
credit bureaus or similar companies in the ordinary course of
business.-[80]- Further, a customer's name, address and
telephone number are not confidential information unless the
customer specifies otherwise.
-[76]- See, comment letters 13, 16, 17, 18,
21, 22, 24,
26, 29, 31, 32, 37, 38, 39, 45, 47, 54, 56, 72, 74,
79, 80, 81,
85, 108, 110, 111, 112, 118, 119, 121, 127, 128, 129,
130, 131,
132, 135, 138, 144, 146, 147, 148, 151, 157, 165, 169,
182, 183,
187, 188, 189, 190, 192, 193, 194, 198, 201, 205, 206,
216, 220,
221, 224, 231, 239, 240, 241, 243, 246, 251, 259,
263, 271, 276
and 280.
-[77]- See, comment letters 6, 10, 59, 193 and
244.
-[78]- See, comment letter 138.
-[79]- See, comment letter 94.
-[80]- The NASD has indicated that credit bureaus
obtain and report
information concerning the creditworthiness of individuals
such as loan
payment histories, checking and savings account activity,
available credit,
and total debt information. Similarly, the NASD staff has
stated its belief
that credit bureaus do not maintain net worth information
including the value
of the customer assets such as property, depository accounts,
certificates of
deposits, securities and other investments. See Letters
from Elliott R.
Curzon and Suzanne E. Rothwell, Assistant General Counsel,
NASD, to Mark
Barracca, Branch Chief, SEC, note 2, supra.
==========================================START OF PAGE 39======
10. Communications with the Public
Paragraph (c)(11)(B) of the original proposed rule change
required that all communications regarding securities
transactions and long and short positions, including
confirmations and account statements, must clearly indicate that
the broker/dealer services are provided by the member and not by
the financial institution, and must be sent directly to the
customer by the member. Commentators, including the ICI, ABA,
BSA, CBA, FRB, and the OCC, asked that this provision be amended
to permit combined account statements of a broker/dealer and a
financial institution as a customer service.-[81]- These
commentators argued that requiring a separate statement would
increase costs, reduce efficiencies and frustrate consumers.
These commentators also noted that the prohibition is
particularly problematic with respect to "sweep accounts" and
individual retirement accounts at financial institutions which
allow for investments in securities products offered through an
NASD member.
Paragraph (c)(11)(B) of the original proposed rule change
also required that all communications sent by the member to a
customer must clearly indicate that the broker/dealer services
are provided by the member and not by the financial institution.
Several commentators asserted that requiring the member to
disclose that the financial institution is not the broker/dealer
may lead to customer confusion.-[82]- These commentators
also asked whether the requirement that the communication
"clearly indicate that the broker/dealer services are provided by
the member" requires an affirmative statement to that effect.
Finally, one commentator argued that identifying a specific
financial institution in the disclosure is burdensome where a
member is networking with more than one financial
institution.-[83]-
Finally, paragraph (c)(11)(B) of the original proposed rules
also required the member to ensure that any documentation
regarding securities transactions sent directly to a member's
customer by an issuer, transfer agent, or principal underwriter
is in compliance with the federal securities laws and NASD rules.
Several commentators argued that the member should not be
-[81]- See, comment letters 15, 23, 26, 28,
30, 31, 35,
39, 40, 42, 43, 46, 47, 48, 53, 54, 56, 58, 69, 71,
75, 76, 77,
78, 80, 83, 86, 110, 115, 116, 117, 119, 122, 123, 124,
126, 127,
128, 129, 131, 135, 136, 140, 143, 145, 146, 148, 152,
156, 158,
159, 162, 163, 167, 184, 186, 187, 188, 189, 190, 192,
194, 199,
200, 201, 205, 207, 224, 233, 239, 241, 243, 245, 246,
248, 251,
276, 279, 280 and 281.
-[82]- See, comment letters 7, 23, 37, 75, 107,
108, 115,
137, 142, 155, 167, 208, 212, 213, 236, 267 and 279.
-[83]- See, comment letter 213.
==========================================START OF PAGE 40======
responsible for correspondence from the issuer, transfer agent,
or underwriter, particularly in the absence of SEC rules
requiring these entities to submit such communications to the
NASD member firm for review prior to dissemination.-[84]-
One commentator also argued that smaller members may not
have the economic clout to require the issuer, underwriter, and
others to submit such documentation to the member in order to
ensure that they comply with the rules.-[85]- Another
commentator asserted that ensuring that documents sent by third
parties comply with SEC and NASD rules would impose strict
liability upon members for matters that are often beyond their
knowledge or control.-[86]- Another commentator stated
that the rule would make the member liable for misrepresentations
appearing in prospectuses and offering circulars about which the
member has no knowledge.-[87]-
In response to the comments received, the proposed rule
change has been amended to permit a joint account statement where
the member's securities products are clearly distinguished from
FDIC-insured products of the financial institution, which is
included as paragraph (c)(6)(A) of the proposed rule change. In
addition, the provision has been amended to delete the
requirement for members to ensure the accuracy of communications
sent by third parties.
Paragraph (c)(11)(C) of the original proposed rules provided
that any advertisement or sales literature, as defined in Article
III, Section 35 of the NASD Rules of Fair Practice, used to
describe or promote the availability of broker/dealer services of
the member on the premises of a financial institution must be
approved by the member prior to distribution, in compliance with
Article III, Section 35(b)(1) and, where required, filed with the
NASD Advertising Regulation Department. Several commentators
asserted that this provision would expand the filing requirements
of members because it would require that all advertisements
issued by a financial institution that mention the member be
filed with the NASD.-[88]- The FRB asserted that the NASD
does not need to review financial institution advertisements that
describe products and services offered by an NASD member because
such materials are reviewed by financial institution regulators
-[84]- See, comment letters 7, 17, 21, 25,
27, 63, 64,
84, 110, 121, 129, 140, 156, 181, 207, 234, 242, 276
and 282.
-[85]- See, comment letter 7.
-[86]- See, comment letter 25.
-[87]- See, comment letter 63.
-[88]- See, comment letters 30, 115, 129 and
211.
==========================================START OF PAGE 41======
to ensure that the materials are accurate and not
misleading.-[89]-
In response to the comments received, the NASD has deleted
this provision and substituted more general requirements in
paragraphs (c)(6)(B) and (C) to require that the financial
institution may only be referenced by a member in a non-prominent
manner in advertisements, sales literature or similar materials,
and that such material, if jointly issued by the member and the
financial institution, must distinguish clearly between the
products and services offered by the member and the financial
institution.
Paragraph (c)(11)(D) of the original proposed rule provided
that advertisements and sales materials issued by the member
which relate exclusively to its broker/dealer services must
indicate prominently that the broker/dealer services are being
provided by the member and not the financial institution; that
the financial institution is not a registered broker or dealer;
and whether the member is or is not affiliated with the financial
institution. The ICI and other commentators asserted that
requiring a member to reference the financial institution for the
sole purpose of complying with this provision, although the
financial institution is not otherwise affirmatively mentioned,
may lead to customer confusion.-[90]- The BSA and other
commentators also argued that stating that the bank is not a
broker/dealer ignores the fact that the bank may be operating as
a broker/dealer exempt from registration under of the 1934 Act.
Indeed, one commentator suggested that stating that the bank is
not a broker/dealer connotes inferiority and misleads the public
by implying that the bank is required to be
registered.-[91]- Another commentator noted that stating
that the bank is not a broker/dealer would be inaccurate with
respect to its particular arrangement because the financial
institution in its case operates a bond department which is in
fact a registered broker/dealer.-[92]-
Some commentators, including the ABA and CBA, stated that no
disclosures should be required beyond what is presently required
by the Interagency Statement (i.e., deposits are not FDIC
insured, obligations of the financial institution or guaranteed
by the financial institution, and involve risks.)-[93]-
-[89]- See, comment letter 103.
-[90]- See, comment letters 7, 23, 37, 75, 107,
108, 115,
137, 142, 154, 167, 208, 212 and 279.
-[91]- See, comment letter 121.
-[92]- See, comment letter 90.
-[93]- See, comment letters 3, 7, 40, 92, 94,
166, 184,
204 and 239.
==========================================START OF PAGE 42======
In response to the commentators, the NASD has amended this
provision, now set forth in paragraph (c)(6)(B), to delete the
requirements that members disclose that the financial institution
is not a registered broker/dealer, and whether the member is or
is not affiliated with the financial institution. The provision
now requires disclosure of any material relationship between the
member and the financial institution.
Paragraph (c)(11)(D) of the original proposed rules also
permits advertisements and sales literature issued by the member
which relate exclusively to its broker/dealer services to
reference the financial institution in a non-prominent manner
solely for the purpose of identifying the location where
broker/dealer services are available. The ICI, BSA, CBA, and the
FRB said that restrictions on references to the financial
institution may be misleading where the financial institution
acts as an investment adviser to proprietary funds.-[94]-
These commentators believe that the restrictions on references to
the financial institution may prevent truthful advertising of the
affiliation between the financial institution and the
broker/dealer. The NASD has modified this requirement, which is
now set forth in paragraph (c)(6)(B) of the proposed rule change,
consistent with the provisions of the Chubb Letter.
Other commentators stated that the limitations on references
to the financial institution set forth in paragraph (c)(11)(D)
are inconsistent with Article III, Section 35, which allows a
member to use a "generic name," provided that the identity of the
member firm and its relationship to the name are conspicuously
set forth.-[95]- The NASD does not intend for the proposed
rule change to modify the ability of members to rely on Article
III, subsection 35(f)(3)(B) to use a generic name.
Paragraph (c)(11)(E) of the original proposed rule change
permitted jointly issued material if the name of the member is
displayed prominently in the section of the materials that
describes the broker/dealer services offered by the member, which
section will be deemed material of the member. This concept of
segregated advertising, according to the ICI, the FRB, and other
commentators, will prove to be problematic in practice because it
is difficult to physically separate the discussion of
broker/dealer services when the product offered includes services
from both the depository institution and the
broker/dealer.-[96]- In response to these comments, the
NASD has amended the provision set forth in paragraph (c)(6)(C)
-[94]- See, comment letters 19, 25, 27, 29,
52, 67, 68,
81, 84, 104, 114, 115, 119, 129, 172, 192, 196, 212 and
245.
-[95]- See, comment letters 17, 21 and 242.
-[96]- See, comment letters 63, 80, 103, 104,
115, 233,
279 and 167.
==========================================START OF PAGE 43======
of the proposed rule change to require that joint sales materials
"distinguish" the products of the member from those of the
financial institution.
Some commentators suggested that the NASD amend paragraph
(c)(11)(E) to provide for introductory letters permitting the
financial institution to introduce financial institution
customers to the broker/dealer.-[97]- The NASD has
determined not to amend the proposed rule change as requested,
because it does not believe the proposed rules currently prohibit
such letters.
Finally, paragraph (c)(11)(D) of the original proposed rules
provided that the financial institution must appear in a non-
prominent manner in advertising relating exclusively to
broker/dealer services, while paragraph (c)(11)(E) of the
original proposed rules states that the name of the member must
be displayed prominently in the section of jointly issued
material that describes broker/dealer services offered by the
member. Some commentators asked that the term "prominently" be
defined.-[98]- Further, some of these commentators
maintained that the provisions are inherently inconsistent with
one another in that they require the financial institution to
appear in a non-prominent manner, while also requiring the member
to disclose that the financial institution is not a
broker/dealer and broker/dealer services are not offered by the
financial institution.-[99]- The NASD has amended these
provisions which are set forth in paragraph (c)(6)(B) and (C) by
eliminating the provisions which create the apparent
inconsistency.
Some commentators asserted that communications with the
public should be uniform among all broker/dealers if eliminating
customer confusion is truly the NASD's goal.-[100]- The
NASD agrees and believes the proposed rule change advances that
goal.
D. Financial Institution Logos.
While the proposed rule change does not specifically address
the issue of the use of financial institution logos in
advertisements and sales literature, several commentators,
including the FRB, asked the NASD to clarify its position on the
use on financial institution logos by NASD members to dispel any
confusion about the permissibility of using financial institution
holding company family logos. The FRB urged the NASD to permit
the broker/dealer to use an affiliated financial institution logo
-[97]- See, comment letters 9, 154, 180 and
213.
-[98]- See, comment letters 80, 135, 140,
181, 213 and
215.
-[99]- See, comment letters 1, 27, 84 and 208.
-[100]- See, comment letters 48, 63, 66, 84, 129
and 208.
==========================================START OF PAGE 44======
to advertise its services.-[101]- Subsequent to the
publication of Notice to Members 94-94, the NASD issued Notice to
Members 95-49 to clarify its previous statements on the use of
logos of financial institutions in advertisements and sales
literature of members in a manner consistent with the Chubb
Letter. The Notice stated that the logo of a non-member
(representative only of the non-member) may only be used in
member communications to identify the non-member entity.
III. DATE OF EFFECTIVENESS OF THE PROPOSED RULE CHANGE AND TIMING
FOR COMMISSION ACTION
The NASD consents to an extension of the time for Commission
action to 30 days from the end of the comment period specified in
Item IV below. At such time, the Commission will:
A. by order approve such proposed rule change, or
B. institute proceedings to determine whether the proposed
rule change should be disapproved.
IV. SOLICITATION OF COMMENTS
Interested persons are invited to submit written data,
views, and arguments concerning the foregoing. Persons making
written submissions should file six copies thereof with the
Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of the submission, all
subsequent amendments, all written statements with respect to the
proposed rule change that are filed with the Commission, and all
written communications relating to the proposed rule change
between the Commission and any person, other than those that may
be withheld from the public in accordance with the provisions of
5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will
also be available for inspection and copying at the principal
office of the NASD. All submissions should refer to the file
number in the caption above and should be submitted by [insert
date 60 days from the date of publication].
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.-[102]-
Jonathan G. Katz
Secretary
-[101]- See, comment letters 11, 85, 103, 121,
140, 184,
189, 191, 216, 234, and 282.
-[102]- 17 CFR 200.30-3(a)(12).